Sunday, November 27, 2011

With all the talk these days about the eurozone crisis, a coming eurozone crash, the death of the euro, etc., I thought it might be helpful to include this chart of the history of the euro from its inception through today, vis a vis the dollar. Maybe both are going down together, but the euro is still strong relative to the dollar. From the looks of this chart alone, you would never guess the euro is in serious trouble. Perhaps because it's not?

The global bond crisis is likely to make stocks richer -- the collapse of debt space is a win for equity space -- too much of the world's economy is tied up in wasteful government sponsored bonds -- again, the global sovereign bond crisis is likely to create a flight to equities as the bond markets shake out...

The strength of the Euro is driven by the massive cash inflow by financial institutions that have been pushed out of the bond market -- Americans often forget how leveraged European banks are (between 40x and 60x). The $30 trillion Eurobond market has been closed for months now.

Default by the likes of Italy is certain to have massive consequences, to think for one minute that this will be good for the equity market is delusional (sorry @dr William).

The forces at play in the dying days of the Euro are complex, and to justify that everything is ok because of the relationship between the USD and the Euro, kind of misses the point -- since America is not exactly out of the woods either.

This is because we haven't seen a TARP-style program out of Europe yet. The entire global market is waiting for one, without which there will be a systemic European bond market collapse. ECB has to backstop the bonds as the lender of the last resort.

Mr. Sarkozy of Carlyle Group thinks that this bailout of European banks will be to the tune of couple trillion Euros. If we can assume that the central bankers will always act in the best interests of the banks, then there's only one way forward: Weaker Euro, Stronger Dollar.

The strength of the euro derives from the ECB's determination to avoid using the devaluation option as a "solution" to the PIIGS' debt problems. Devaluation is a very pernicious way for a government to be relieved of its debt burdens, since it forcibly transfers wealth from the private sector to the public sector, and those who are least knowledgeable of how this works and unable to hedge themselves (e.g., the poor and middle class) are the ones who end up bearing the lion's share of the burden. If the ECB were to capitulate and devalue the euro, then that would be a terrible blow to the eurozone economies.

A big euro devaluation would lead to a significant rise in imported prices and eventually a big rise in Eurozone inflation. Substantially higher inflation would inevitably erode the purchasing power of workers, since salaries typically lag a rise in inflation. It would also increase uncertainty in the euro and the Eurozone economies, thus inhibiting investment and slowing the rise in living standards.

To protect against a devaluation you can own significant amounts of real assets (gold, property), significant amounts of assets denominated in other currencies, or you can employ standard hedging techniques. The layman is unlikely to be adept at any of this.

Interesting Statement: "and those who are least knowledgeable of how this works and unable to hedge themselves (e.g., the poor and middle class) are the ones who end up bearing the lion's share of the burden"

Aren't the poor and middle class bearing the burden in the United States then, since TARP has already happened here and banks got bailed out?

How is it that none of those malinvestments did not get purged and the future of US economy looks fine to you? Isn't the soverign debt crisis a problem for the US too, just hasn't manifested yet here?